Marginal costs in relation to values. General principles

Book 5, Chapter 8

§1. “And again this demand [for an input], because it is so derived, is largely dependent on the supply of other things which will work with them in making those commodities [final goods]. And again the supply of anything available for use in making any commodity is apt to be greatly influenced by the demand for that thing derived from its uses in making other commodities: and so on. These inter-relations can be and must be ignored in rapid and popular discussions on the business affairs of the world. But no study that makes any claim to thoroughness can escape from a close investigation of them. This requires many things to be borne in mind at the same time: and for that reason economics can never become a simple science” [p 334 emphasis added].

§2. The demand (=price) of inputs that can be substituted for each other (e.g., steam vs horse-power) will depend on relative efficiencies, with exceptions for laws, custom and other frictions. A horse that produces 10% of a machine’s output will attract offers equal to 10% of that machine’s price.

§3. Businessmen are always experimenting with the mix of inputs required to get a desired output. Although accounting for marginal and capital costs (and depreciation) is not easy, prices and costs will, over time, tend to reflect each input’s value added.

§4. The balance among inputs of capital, labor and materials will tend to equate, at the margin, with their marginal products (i.e., ratios of values to costs). An over-application of any input is wasteful due to decreasing marginal returns (on that input) and opportunity costs (not using other inputs).

In a long footnote, Marshall argues against those who see any given input as “essential” in that a small reduction in its use (e.g., a worker who labors one hour less) will have dramatic effects on the productivity of other inputs.  While this might be true in the short run, Marshall argues that changes here  can be balanced by (continuous) adjustments elsewhere. This appeal to continuity underpins the use of calculus (finding minima and maxima by taking derivatives of functions), which makes sense in many circumstances. I disagree with the continuity assumption when it comes to constraints (an 8 hour shift) or innovations (the shift is eliminated). I assume Marshall would have agreed but modern (=mathy) economists may have forgotten those important caveats and exceptions.

§5. The decision to add/subtract inputs is made “at the margin” in terms of weighing additional profits (or value) vs costs. That calculation takes existing levels of inputs as given, which also means that removing a unit at the margin has a far smaller effect than removing an “inframarginal” unit. In this way, we can see how it might be ok to, say, skip another hour of sanding down a chair while it might be a bad idea to skip an hour of adding legs to that chair. Order matters.

§6. The rents (or interest) returned to “free floating” capital versus “invested” capital varies with the longevity and idiosyncrasies of investments, but they tend to converge.

This post is part of a series in the Marshall 2020 Project, i.e., an excuse for me to read Alfred Marshall’s Principles of Economics (1890 first edition/1920 eighth edition), which dominated economic thinking until Van Neumann and Morgenstern’s Theory of Games and Economic Behaviour (1944) and Samuelson’s Foundations of Economic Analysis (1946) pivoted economics away from institutional induction and towards mathematical deduction.

Author: David Zetland

I'm a political-economist from California who now lives in Amsterdam.

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